In: Finance
Company X has 2 million shares of common stock outstanding at a book value of $1 per share. The stock is currently priced at $5.00 per share. The company also has $2 million in face value of debt, with exactly 15 years remaining until maturity and a coupon rate of 10% paid semiannually. The yield to maturity on the bonds is 12%.
What is the weight of debt capital to be used in calculating the firm’s weighted average cost of capital (WACC)?
A) 14.71%
B) 15.30%
C) 46.30%
D) 50.00%
Step 1: Bond price calculation
Bond Valuation: The value of bond is the present value of the expected cashflows from the bond,discounted at Yield to Maturity(YTM).
note: It is general practice to take $1,000 as face value when no details are given.
Prima facie, the bond will trade at discount as YTM>coupon rate
Year | Cash flow | PVAF/PVF@6% | Present Value (Cashflow*PVAF/PVF) |
1-30 | 50 | 13.7648* | 688.24 |
30 | 1000 | 0.1741** | 174.11 |
Current Market Price of Bonds = Cashflow*PVAF/PVF
= 688.24+174.11
= $862.35
Note : Since the bond makes semiannual interest payments, total no. of period is 30 (15*2), cashflow per period is 50(1000*10%/2) and cashflows are discounted at 6% (12/2).
*PVAF = (1-(1+r)^-n)/r
**PVF=1/(1+r)^n
Weight of debt capital = Market Value of Debt/( Market Value of Equity+ Market Value of Debt/)
= ((2 million/1000)*862.35)/(((2 million/1000)*862.35)+(2 million*5))
= 1724700/(1724700+10000000)
= 1724700/11724700
= 14.71%